Basic Calculations for a Multi-Family Rental Property

What is involved when it comes to multi-family financial calculations?  Lots of numbers to be sure -- but the actual math involved is not that difficult.  The real challenge lies in getting the right data to use in your calculations. 

There are a number of calculations that may be used in the financial analysis of a multi-family property.  These factors include the capitalization rate, cash on cash rate of return, debt coverage ratio, gross rent multiplier, internal rate of return and financial market rates of return, market analysis, price per unit, and price per square foot.

Let's take a look at how the key financial measures are calculated, starting from the fastest and moving to the most complex. 

 
GRM = Gross Rent Multiplier

• Purchase Price / Annual Gross Rents = GRM

• Lower is better.  Very fast screening tool for apartment deals

• Example:  An apartment building is priced at $1 million and has annual gross rents of $150,000. The GRM = 6.7  ($1,000,000 / $150,000). 

Average GRM’s vary widely based on:

• Geography (San Francisco around 15 GRM, Syracuse around 4 GRM).

• Property Quality (Class A commands higher GRM than Class C).

The primary advantage of this tool is that it’s very fast to calculate.  The primary disadvantage is that it’s a very poor indicator of profitability as it ignores vacancy, expenses, repairs, etc.

 
ConC = Cash on Cash return

• Total pre-tax cash received / Total cash invested in deal = ConC (also called ‘Yield’)

• Primary concern of ‘passive income’ and cash flow investors

• Example:  Our $1 million apartment building above was purchased with 20% down payment, or $200,000. If the total cash flow before taxes was $16,000, the cash on cash return would be 8.0% ($16,000 / $200,000 = 8.0%):

Note the above did not include closing and other initial out-of-pocket expenses for simplicity.  Most investors include every dollar required to close the property in this calculation.
 

NOI = Net Operating Income

• Total Income less all expenses except debt service = NOI

• Example:  Our $1 million apartment building above has the following summarized financials:

        Total Income               $150,000

        Total Expenses            $  60,000  (everything except principal & interest)

        NOI                           $  90,000

• ALWAYS understand exactly how NOI was calculated before trusting a NOI figure.

 
Cap Rate = Capitalization Rate (a.k.a. “the Cap”)

• NOI / Purchase Price = Cap Rate

• Example:  Our $1 million apartment building has a Net Operating Income (NOI, equals free cash flow before debt service) of $90,000.  The cap rate for this property = 9.0%.  ($90,000 / $1,000,000 = 9.0%.

• This is the un-leveraged annual rate of the investment.

• Top screening criteria used by investors, often a hurdle rate for moving forward with an investment

• It’s critical to understand each input used in calculating a cap rate to ensure it’s an accurate measure of expected performance.  “Garbage In, Garbage Out”.

• Also useful in reverse to calculate what you’d pay for a property where the NOI is known.  $90,000 / 10.0% cap rate money rule = $900k max purchase price.

DSCR (or DSR) = Debt Service Coverage Ratio

• NOI / Total Debt Service (all mortgages) = DSCR

• Example:  Our $1 million apartment building has a mortgage for $800,000 at 8.0% over a 25 year amortization period.  The annual P&I payment is about $74,000.  The NOI calculated above is $90,000.  The DSCR for this property = 1.22.  ($90,000 / $74,000 = 1.22)

• This is a commercial lender measure, usually require 1.20 or greater to get financing.  Lenders want to know the property can pay the debt service with some margin for error.

• In residential loans, your debt to income ratio serves a similar purpose.

IRR = Internal Rate of Return

• Best (and most complex) measure for comparing investments on an ‘apples to apples’ basis

• Often very difficult to get accurate data for all required inputs

• Takes into account both the time value of money and the opportunity cost of what that money could be earning elsewhere (or the cost of the capital if borrowed).

• Standard measure for REIT’s, pension funds, and other very large and sophisticated investors.  Almost never used in residential or smaller multi-family. 

 
Calculating both the price per unit as well as the price per foot is a good way to quickly evaluate a property in relation to similar properties in the same area.  The price per unit consists of dividing the sale price of a property by the number of units involved.  The price per square foot is found by dividing the property cost by the total amount of square footage.  

Two final tips in analyzing properties...

1. Make sure you capture ALL expenses incurred in running the property.  Many brokers and sellers advertise great numbers but leave out some costs that you will incur if you buy the building.  Get professional help before signing a contract if you're unsure that your numbers are correct.
2. Try to get the current owner's last 2-3 years of tax returns for the property.  This likely is the worst case scenario from the last couple years of operations as the owner wanted to pay the least amount of tax to the IRS!